As America inches closer to hitting the debt ceiling, the financial markets have been reacting like a nervous Pekingese, skittering around unpredictably in a desperate attempt to avoid getting stomped on. The most you can say about both the stock and bond markets is that they're "unstable," looking for news to give them direction.
How should you alter your financial life in response to the U.S. government's seeming inability to deal with its debt and chronic overspending?
1. Evaluate your portfolio. You should never undo a reasonable investment strategy to react to a short-term problem, but if you are not so sure that your investments are reasonable for your situation, you need to look at that now.
Is the money you need for short- and medium-term goals -- that's anything that happens in the next five years -- sitting in investments that don't swing wildly in value? If not, it should be. The right investments for these shorter-term goals are: bank accounts, certificates of deposit, money market mutual funds and accounts; and shorter term bonds.
If you have bonds or bond funds, make sure that the maturity matches when you'll need this money. In other words, if you have a child going to college in five years and want the money for the first year's tuition to be secure, you'd put that money either in CDs with maturities of 5 years or less or in an investment-grade bond that matured in five years or less.
Your stock investments need to be for long-term goals and widely diversified.
2. Check & refresh your emergency fund. When the government acts irresponsibly with its money, you need to act doubly-responsibly with yours. Make sure you have money set aside to handle emergencies -- and set aside more than you think you'll need. In a normal market, it makes sense to have an emergency fund equating to three- to six-months worth of spending; in today's market, you might want to double that amount, if you can.
3. Lock in a fixed rate. Interest rates are at historic lows. Use this moment to lock in these low fixed rates for any long-term debt. Why? If the government doesn't get a handle on its debt, future interest rates are sure to rise. (They're likely to rise when the economy recovers too.) If you have variable rate debts, your cost of living could rise with interest rates. This is a particular concern if your variable-rate loans are big -- student debts or mortgages, for instance.
If you have government-guaranteed student loans, you can lock in your current rate by "consolidation" with the Federal Direct Loan Program. If you have a mortgage, check out these 5 Rules for Refinancing.
4. Watch cash flow. If you invest in individual stocks, you should realize that corporations are going to be dealing with many of the same issues as households. If interest rates rise, those who have more income than expenses, will be in a great spot. Those that spend more than they earn will find borrowing increasingly costly. As an investor, that means you should pay a little more attention to "cash flow" than normal. (Both yours and the cash flow of any company you invest in.) In a rising rate environment, cash rich companies become increasingly attractive.
5. Hold on. When the investment world's "safe haven" -- U.S. Treasuries -- starts to look risky, it virtually guarantees volatility in the financial markets. The worst thing a long-term investor can do in a volatile market is react in haste. Invest your long-term assets based on long-term trends. Do your best to keep calm and remind yourself that long-term investments are for long-term goals. As long as your stocks are widely diversified, do not tinker with them unless your goals have changed.
On an related note: You might also want to demand that Congress take a pay cut of its own. Last year Rep. Ann Kirkpatrick introduced a bill to cut rich Congressional salaries by a modest 5%. Legislators ignored the bill, letting it "die in committee." This is a cowardly way to avoid a public vote. The government is now talking about cutting Social Security, Medicare, Medicaid and education. Isn't it time to revive this bill to cut legislative pay?
Kathy Kristof is the author of Investing 101
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